Homeowner bailouts benefited lenders far more than homeowners

While some underwater homeowners were saved by federal reserve policy, the main beneficiaries of this stealth bailout were the banks.

The populace was sold on quantitative easing and mortgage interest rate stimulus as a measure to save “Main Street.” It was said this money pumped into the economy would create jobs, and the combination of jobs, increased incomes, and low mortgage rates would cause a boom in housing which would elevate loanowners above water. What was sold as a big benefit to Main Street devolved into another massive bailout of the banking industry with few tangible benefits to the people the programs were ostensibly designed to help out.

Proponents of these policies can point to the rapid increase in house prices since 2012 as a sign of success. While it’s true that many loanowners have emerged from beneath their debts, this policy wasn’t designed to keep them in their homes. The interest rate stimulus has merely elevated prices so when the terms of loan modifications increase borrower costs and push them out, the lender losses less money.

The policy of mortgage interest rate stimulus is a success from the perspective of a banker because higher house prices are helping them recover more money from their bad bubble-era loans. However, wouldn’t the real measure of success from the perspective of Main Street have people remain in their homes rather than simply improve the bank’s bad debt recovery?

And what about future buyers? They are being forced to pay bubble-era peak prices and endure a much higher cost of ownership. Is that a success for Main Street? It looks much more like a success for lenders. Not just do they recover more on their bad loans, they also get more interest income because they are making large loans to today’s homebuyers. It’s a win-win for the banks.

However, the biggest back-door bailout of them all is the quantitative easing policies of the federal reserve. Basically, the central bank is printing money, some of it has flowed into mortgage bonds to drive down mortgage rates, but much of it has made it’s way onto bank balance sheets and into deposits at the federal reserve who pays those banks interest on the money the federal reserve prints. Not a bad deal — for the banks.

The federal reserve can only create money by loaning money. It can’t merely print dollars and put them into circulation. It generally buys US Treasury notes (Government debt) to print money, but it now also buys mortgage-backed securities (private debt).

How much of this money has made it’s way to Main Street? Does the average American feel the benefits at this point?

Availability of money to lend wasn’t a problem for the banks — which is unfortunate since that’s the only problem the federal reserve can do anything about. The real problem for banks was the lack of good prospects for loans to give the money to.

The problem was insolvency. Nobody had the income to support the debts they already had. Insolvency is a much more serious problem than liquidity, and the federal reserve has only one tool to deal with it — ultra-low interest rates. They can make the marginally insolvent borrower solvent again by lowering their cost of debt, but that’s about it. Adding liquidity does nothing to improve the problem of insolvency. Potential borrowers need stable and expanding incomes, and they need to pay down the debts they already have. That takes time — a long time.

Wall Street needed to make more money to make up for the massive loan write-downs they were making. The above chart showing declining loan balances didn’t happen because people took money out of their savings and paid down debt. Those reductions were caused by bank write downs, mostly on mortgage debt.

As the federal reserve lowered interest rates, particularly using QE to buy 10-year treasuries, it served as a direct bailout to lenders, though this is often overlooked and misunderstood by most people. I want to make sure you understand how this part of the bailout worked.

Mortgage bond prices are inversely related to interest rates. Interest rates go down when bond prices go up. Since the federal reserve was buying a lot of bonds to drive down rates, the prices of bonds rose a great deal. The banks knew this was coming, so they loaded up on 10-year Treasuries and other bonds, held them while the federal reserve bid up prices, then sold these bonds to the federal reserve at nosebleed prices.

In that way, banks made billions in capital gains by taking the money given to them by the federal reserve, buying bonds, then selling them back to the federal reserve. It was free money given to the banks by manipulating bond prices — and they made transaction fees on these deals to boot.

That’s a pretty good deal for the banks, wouldn’t you say?

And it was no small bailout. Over five years, its bond purchases have come to more than $4 trillion. Not all of this was profit to the banks, but a significant amount of it was.

I made the argument that the housing market bottomed due to decisions made in the boardrooms of the major banks. It’s a cartel arrangement. Those 0.2% of institutions that control 70% of the assets made a conscious decision not to foreclose on delinquent mortgage squatters, deny short sale approval to those who do want out, and cut deals with the rest until house prices get back to the peak.

It’s been argued that these banks are just doing what they’re told by the government. Well, the government told them to modify instead of foreclose from 2008-2011, and it didn’t dry up the MLS inventory of foreclosures.

Something changed in mid to late 2011 that caused the number of foreclosures processed to decline significantly — and it wasn’t that they ran out of people to foreclose on. Was it a secret meeting in a smoky room? That’s how JP Morgan did it in 1907. We may never know, but what we can see from the evidence is that policies changed, and the distressed inventory was removed from the MLS causing house prices to bottom.

Do you still believe quantitative easing and mortgage interest rate stimulus was designed to help you? I think it was designed to help the banks, and the evidence supports that view.

* Homeowners are confident about the current state of the housing market, and the majority believe now is a good time to sell a home.

* Renters are less confident than homeowners, with only 37 percent confident that they will be able to afford a home in the future.

* The most confident homeowners are concentrated in Western and Southwestern cities, like Seattle and Dallas, which also have the least confident renters.

* Overall U.S. housing confidence inched up in July to 67.3, up 0.4 from January 2016.

Homeowners have a lot of swagger in today’s market, and for good reason – home values are rising, demand is high and homes are selling very quickly. But the same trends helping to buoy homeowner confidence are also proving increasingly discouraging for potential buyers, particularly among current renters, a critical imbalance that could have important impacts on the market going forward.

Additionally, while overall confidence in the housing market is up nationwide, several indicators point to fading confidence in a number of large markets – particularly the most expensive and/or fastest-growing markets, according to the July 2016 Zillow Housing Confidence Index.

Of the 20 metro areas analyzed as part of the ZHCI, this gap is widest in San Francisco (73 percent of homeowners think it’s a good time to sell, versus 13 percent of renters saying it’s a good time to buy)

Last week I was driving throughout the Inland Empire and one thing becomes rather apparent. There is a ton of building out in the Inland Empire – this applies to work on freeways, new housing communities, and new commercial development. Also, traffic is a nightmare. Westside traffic is also horrendous. There are many people that make the commuting odyssey each day from the Inland Empire into L.A. or O.C. and that commute is only going to get worse from what I was seeing. I was also in the Bay Area recently and prices there defy gravity. In the Inland Empire you can get a McMansion while in the Bay Area you will get a crap shack for one million dollars if you are lucky. It really boils down to a lack of housing inventory and uncertainty that has made builders anxious since the housing bubble is fresh in their collective memories. But alas, the public is drawn to housing like moths to the light. Being stuck in mind crushing traffic for a brief period only highlights that people are willing to sacrifice quality of life for a piece of the American Dream.

[Dr. Housing Bubble profiles a double flip in Oakland that is really outrageous.]

Today I had my first uninterrupted commute between my new rental in Portola Springs and my new office by the Irvine Spectrum. From the time I turned on my car until the moment I parked it, only 8 minutes elapsed. That’s the kind of commute I like.

Congrats on the new job! I was noticing that there seem to be more building industry jobs listed in a recent cursory search of LinkedIn than I ever remember seeing since the downturn. Have noticed this as well?

Yes. Particularly over the last 6 to 9 months. Many of these jobs are actually hiring now as well. Many of the job postings over the last several years were human resources people trying to keep busy. I watched Lennar post a project manager job every 3 to 6 months for three or four years. I interviewed with them at one point, and the guy told me they hadn’t hired anyone since the recession.

Comparing rental markets in the twelve countries revealed that the US was exceptional in a number of (often unfavorable) ways. The median ratio of housing cost to household income (Figure 2) was greater in the US than in any of the other countries studied, except for Spain, where there are relatively few renters. Moreover, the share of renters with severe cost burdens — paying more than 50 percent of their income for housing — was greater than in any of the other countries (Figure 3.)

Other exceptional characteristics of renter households in the US included an average household size of 2.39, which is greater than in any of the other countries, except Spain. The share of US renter householders aged 65 or over (12.1 percent) was less than in any of the other countries, again with the exception of Spain. Also, the share of renters living in single-family detached houses was much higher in the US compared to the other countries.

It’s different in Coastal California, right?

Since the downturn, home prices for the US as a whole have been undergoing a strong recovery and are now approaching their former peak from the mid-2000s. However, the recovery has been uneven across the nation’s metro areas. As of June 2016, median home prices in only about a third of all metro areas tracked by Zillow since 2005 (162 of 474) had regained their mid-2000s peak values. In some metros, home prices remain 20 to even 30 percent below past peaks. To get a picture of the extent to which markets differ, we can examine the recovery in home prices, see where prices stand in metros across the country, and consider the implications of the changes.

At the positive end, some metros have done far more than just recover, with home values rising above past peaks (Figure 1). A few of these metros are hot markets where home values have skyrocketed after substantial declines during the downturn. Examples include San Jose and San Francisco where median home values are now significantly above mid-2000s peaks, following significant declines in the late 2000s. Honolulu and Portland, OR experienced similar trends. However, these four metros are the exceptions, as the majority of metros with above-peak values have not seen particularly strong recent price appreciation and are mostly benefitting from their relatively minor price declines during the downturn. In fact, among the fifteen metros where current home values most exceed past peaks, five had total peak-to-trough declines of less than 3 percent. Five others had declines of less than fifteen percent, which was still well below the US nationwide peak-to-trough decline of 22.4 percent.

At the other end of the spectrum, home values remain far below mid-2000s peaks in several metros, predominately located in the Southwest and Florida. These are areas that had the most severe price declines during the recession—some declined in excess of 60 percent—which results in home values that continue to appear depressed despite significant recent rates of appreciation. In fact, metro areas furthest from their former peak values include areas where home values have risen most sharply since the recession. For example, Modesto, California’s median home value has nearly doubled (up 92 percent) since its November 2011 low of $129,400, reaching $248,900 by June 2016. This makes it the metro with the largest percent increase from trough to current, but Modesto’s median home value is still 31 percent below the April 2006 peak of $362,100. This pattern holds true for a number of other metros in California, Florida, Arizona, and Nevada.

On a percentage basis, the appreciation in those beaten down markets has been remarkable.

When I convinced my parents to go to Las Vegas and buy homes, at first they were hesitant because their retirement plans were set. After putting $16,000 down on their first rental and $3,000 down on a primary, the cashflow from the first rental made half the payment on the primary. Next year, my father thinks he can sell the first rental for enough to pay off the primary, get his down payments back, and pay the capital gains tax. Basically, due to their timing, they will have a free house.

“How much of this money has made it’s way to Main Street? Does the average American feel the benefits at this point?”

It’s a complicated question. Loudmouth pundits, most poorly educated and/or not educated/informed in economics (e.g. Santeli on CNBC) will tell you with absolute certainty how their counter factual world would appear if their solutions were implemented. Educated folks, especially economists, provide a much more nuanced answer with great detail. It certainly doesn’t make a great sound bite.

Eventually, if we print enough money, it will make its way down the food chain to ordinary people. Santeli and the tea party crowd hates it because if they print enough money, they will dilute the value of the wealth many of those guys have. The battle between left and right on financial issues usually boils down to whether or not inflation is viewed as good or bad. The left embraces inflation while the right loathes it.

I would note that so far, not much has made its way back to Main Street. The rich have enjoyed the reflation of the values of most of their assets while incomes haven’t kept up with what little inflation we’ve had.

Regardless of agenda, the reasonable prudent thing to do on any issue, is to read detailed arguments carefully and consider. The pundits tend to have little analysis, and their logic is almost always riddled with fallacies. This is not the case in most economists’ writings.

The economists for the trade organizations tend to be. Many private economists are good and provide quality information to their clients. The trade organization economists are merely mouthpieces and market cheerleaders.

I thought we were talking about economists prominent in the media. Those that work in a private capacity are a different story. Academics are a mixed bag, depending on the level of real world experience they possess.

It’s happening all across America right now: Hordes of renters, innocently perusing their social media accounts, are noticing a theme. It’s not that everyone is getting married or obsessing over spiralized vegetables — they’re posting pictures of newly purchased homes.

But like your mother always said, just because everyone is doing it doesn’t mean you should — or should you? There are certainly pros and cons of becoming a homeowner, and stumbling across just one dreamy listing of a home for sale in Anaheim, CA, with the perfect open-concept kitchen and fenced-in backyard can leave you thinking about little else. But then you realize you’d rather save your money for a travel adventure, and said dreamy house doesn’t come with the amenities you love at your apartment, like an on-site gym, pool, and doggie day care.

Don’t jump the gun and assume you need to buy a house. Here’s some truth talk: You might not be ready to buy. Pay attention to these seven signs that reveal that even if you think you’re ready to buy a house, you might not be.

Folks need more guidance here though. How much money do you need to make to buy how much house? How do you know if you have too much debt? How do you know what level of savings is best before buying a house?

That’s one of the main reasons I provide all that on each property for sale. Those details are important, and most people really don’t know the answers. Fortunately, the loan underwriting process is much better at educating people than ever before because the silly loans outside safe parameters simply aren’t offered.

Will the risk of overheating in the U.S. commercial real estate market prompt the Federal Reserve to move more quickly on rate hikes despite lackluster economic growth?

Perhaps, says Boston Fed President Eric Rosengren, it should.

Eight years of extremely low interest rates have pushed commercial real estate prices up rapidly, and they might also decline rapidly if economic conditions change, Rosengren said in remarks prepared for an event hosted by the Shanghai Advanced Institute of Finance this morning in Beijing.

Because many banks hold real estate debt, they might sustain losses that force them to decrease consumer lending, sending shock waves through the consumer-driven U.S. economy.

While Rosengren, a voting member of the U.S. central bank’s monetary policy committee, isn’t predicting such an event, it could “make a recession worse than it would have been had policymakers normalized interest rates more rapidly,” he noted.

It’s an important consideration for the Federal Reserve as its monetary policy committee weighs what would be only its second hike in short-term interest rates since they were cut to nearly zero to bolster the economy during the 2008 financial crisis.

While the central bank indicated it might raise rates as many as four times this year after a 25 basis-point boost in December, it later halved the forecast amid market volatility.

Rates, which now range from 0.25% to 0.5%, haven’t been touched since, though Fed Chair Janet Yellen said this month that a strong labor market strengthens the case for an increase. Still, price inflation, the other half of the Fed’s monetary policy calculus, remains below the central bank’s 2% goal, as Rosengren noted.

Is the window for oversized returns on commercial real estate behind us? Quite likely, according to Goldman Sachs, which recently issued a report implying real estate stocks may now be too risky for investors.

Real estate industry experts have mixed views, however, about whether the ship has already sailed for high returns on commercial real estate investments.

“People have read this report as if to say that this is no longer a time to get into real estate. I disagree in the sense that it assumes that people have just one motivation when investing,” says Jim Costello, senior vice president with New York City-based research firm Real Capital Analytics (RCA). “One can have a number of motivations while investing, and different types of real estate and different real estate vehicles can satisfy these motivations.”

Don MacLellan, senior managing partner with Irvine, Calif.-based real estate investment advisory firm Faris Lee Investments, is not seeing evidence of reduced capital allocation for core retail properties, for instance, though he admits that cap rates for core grocery-anchored centers in major California markets are now at record lows—such properties are trading in the mid-4.0 percent.

“I disagree that investors have missed the boat—it is really a function of the market. It’s hard to make such a blanket statement,” he says.

Still, there is a feeling in the air that returns in this cycle will no longer reach the double-digit highs seen in the past few years, according to Andy Moylan, head of real estate products at London-based research firm Preqin. At the same time, he says there is still “plenty of capital” being raised, though the numbers are trailing below last year’s.

Back when it was home to a DHL shipping hub, Wilmington, Ohio (population: 12,449 and shrinking), seems like it was a lively little city. In 2007, a local bookstore, Books ‘N’ More, threw a release party for “Harry Potter and the Deathly Hallows” that drew 10,000 people downtown.

DHL left in 2008. Books ‘N’ More closed in 2014. But now Amazon.com is beginning to use Wilmington’s airport for its own delivery airplanes. In his Bloomberg Businessweek cover story this week about Amazon’s shipping offensive, Devin Leonard recounts a funny little exchange illustrating the mixed feelings that this generates. John Stanforth is Wilmington’s 71-year-old mayor. Marian Miller and Bret Dixon are local officials who are extremely enthusiastic about having Amazon in town.

“They are a feel-good company,” says Miller. “Who wouldn’t want a feel-good company like Amazon? Look at the way they treat their customers and their employees!”

The conversation turns to those Harry Potter events. Stanforth perks up. “Well, we had a local bookstore that really promoted it and took the initiative,” he says. “Sad to say, it’s closed up. Wonder who closed them up?”

Miller gives him a look. “Don’t say it.”

“Where does everybody get their books now?” Stanforth says, grinning.

“Don’t say that,” Miller warns him again.

“Amazon,” Stanforth says.

“I knew you were going to say it,” Dixon says, shaking his head.
The relationship between independent bookstores and Amazon is a little more complicated than that: Amazon’s rise has been hardest on big chains such as Barnes & Noble and Borders (RIP), and the chains’ decline has actually ushered in a modest indie resurgence.

Still, Mayor Stanforth is onto something: The rise of big national retailers has been devastating for many pillars of local communities such as Books ‘N’ More. This is a story that long predates Amazon, and one can make the case that the effects have been on balance positive. Here’s Jason Furman, now the chairman of the president’s Council of Economic Advisers, making a numbers-based defense of Wal-Mart in 2005:

There is little dispute that Wal-Mart’s price reductions have benefited the 120 million American workers employed outside of the retail sector. Plausible estimates of the magnitude of the savings from Wal-Mart are enormous — a total of $263 billion in 2004, or $2,329 per household. Even if you grant that Wal-Mart hurts workers in the retail sector — and the evidence for this is far from clear — the magnitude of any potential harm is small in comparison.
What such an accounting leaves out, though, is the value of locally owned businesses, of local control. I don’t quite know how to quantify that value, but it isn’t nothing, and political leaders used to fight hard to preserve it. As the New America Foundation’s Phillip Longman wrote in the Washington Monthly last year:

Throughout most of the country’s history, American government at all levels has pursued policies designed to preserve local control of businesses and to check the tendency of a few dominant cities to monopolize power over the rest of the country. These efforts moved to the federal level beginning in the late nineteenth century and reached a climax of enforcement in the 1960s and ’70s.
Since the 1980s, economic activity and wealth in the U.S. have become increasingly concentrated in a few big metropolitan areas, mostly along the Atlantic and Pacific coasts. The standard explanation for this Great Divergence, as University of California at Berkeley economist Enrico Moretti has dubbed it, is that, as I wrote in February:

The most vibrant, important sector of the economy is what he calls the “innovation sector,” and its workers thrive in the presence of lots of others like them. So clusters of innovation such as the San Francisco Bay Area, New York, Boston and Austin, Texas, will keep creating good jobs, and most other places won’t.
If that’s the main force driving the divergence, then the policy response should probably involve (1) finding ways to build more housing in those innovation clusters so workers can afford to live there and (2) helping people from struggling towns and cities move there. Maybe we could also foster the development of a few more innovation clusters, but that’s really hard to get right.

Longman’s thesis, though, is that the divergence is mostly due to a shift in government policy that began in the late 1970s. Government went from fighting economic concentration to tolerating it (by cutting back on antitrust enforcement) and even egging it on (by deregulating transportation and finance, increasing protection for intellectual property, and other means).

This was all well before the dawn of the commercial internet, of course. Because the internet is a decentralized, distributed network, many boosters predicted during its rise in the 1990s and early 2000s that it would counter the trend toward economic concentration and bring a new age of decentralization and individual empowerment. In some areas (economics commentary, for example) this has arguably happened. But on the whole, U.S. economic activity has just been getting more concentrated in large companies. And when you read about Amazon’s bold plans to make it ever cheaper and more convenient to get everything you need delivered to you at home by Amazon, it seems clear that it’s only going to get more concentrated.

So here’s the question: Should Americans be fighting against this? My Bloomberg View colleague Conor Sen argued last week that we shouldn’t get too worked up about crazy housing prices in innovation clusters such as New York and San Francisco, because they are having the positive effect of driving talented people and economic activity to other cities. But what about taking things a step further, and actively legislating against economic concentration? Remember, doing so used to be the norm in the U.S. It seems terribly retro right now — sort of like a locally owned bookstore on a small-town Ohio Main Street. But ideas do have a way of coming back into fashion.

This is a topic that’s been on my mind since coming back from my vacation. The small town where I grew up hasn’t changed in 50 years — literally. The population growth hasn’t kept up with the birth rate, and incomes haven’t kept up with inflation. To call the economy moribund is to give it more credit for life than it has.

I suppose the lack of economic opportunity is what keeps small towns small and quaint, so advocating a resurgence of small-town economies would kill the very thing that makes the small town interesting. I don’t know what the answer is, but I can’t get behind government policies that attempt to social engineer changes to the way the economies work in these areas.

The bottom line is you can’t start a business or pursue a career that attempts to go against globalization. A like local bookstores myself, but the reality is they are fighting a losing battle on multiple fronts. Many people would rather look at devices than read books, so their customer base is in decline, and buying books online is cheaper and easier, so those that still do like to read would rather have the convenience of shopping online and paying less.

The only way stores like this can succeed is if they create a community gathering place by having signings, book clubs, special events, etc. It sounds like they tried to do that, but a town of 12,000 and getting smaller is still not a very big customer base for a place like this. These types of places still do well in bigger cities in areas where cultural vibrancy is present.

I think the question is bigger than that because it depends on who absorbs the losses.

Lender lobbyists want to see the credit box expanded back to the bubble era because all the risk is on the US taxpayer. As a US taxpayer, I think the credit box is perfect right now because I don’t want to be on the hook if a loan goes bad. When private capital takes the risk, they can set the default rate at whatever they want because they will absorb the losses if they reach too far.